December 12, 2002 Commentary # 4
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RE-PURPOSING COMMENTARY CONTENT ON
OTHER SITES: The
answer is “yes.” What is the possibility?
YEAR-END THEME: CHANGE “CHANGE
MANAGEMENT”
This is
the second of three commentaries that will focus on doing things better in
2003. For better or worse, many companies plan their big initiatives and
incentive compensation around calendar numbers making December a month for
reviewing THE 2002 PLAN results and re-casting new PLANS FOR 2003. Because
success rates for 2002 plans may have fallen short and our 2003 economy may
well be challenging, maybe now is a good time to think about how to change how
we pursue change. I hope the chosen topics in our last commentary and this one
will help 2003 plans be more fruitful.
TOPICS: HOW TO INCREASE FINAL EXIT
STRATEGY VALUATIONS
1. A review on the book “A Stake in
the Outcome” by Jack Stack. Currency/Doubleday, 2002.
2. Case Study – “Bruce, what is my
building supply distribution company worth? When should I sell?”
3. Post-Bubble Economics picture story:
Why exit options and company valuations are dropping.
1.
BOOK REVIEW of “A STAKE IN THE
OUTCOME” by Jack Stack
Who’s Jack Stack? For the past 20 years he has been the
CEO of what is now an umbrella holding company called SRM in Springfield, MO. In the early ‘80s he and eleven
other managers bought Springfield Re-manufacturing Company from a parent
organization, International Harvester, which at the time was on its way to
bankruptcy. The buyout was financed at an 89 to 1 debt to equity ratio.
“A Stake in the Outcome” is a
sequel of sorts to one that Stack co-wrote with Inc. Magazine in 1992 entitled:
“The Great Game of Business”. The magazine had discovered SRM in 1990 for one
of its “fastest growing private companies in the US” stories. The magazine had
become smitten with SRM’s style of “open-book management” (OBM) and Jack’s
diehard commitment to having every employee have an emotional, financial, stock
investment in the company; to literally be “an owner”. In true
“intrapreneurial” fashion, SRM developed a spin-out business from the success
of “The Great Game of Business”. You can check it out at
www.greatgame.com.
I liked the first book that went into the mechanics of
their OBM process, but it didn’t look past the survival and now thriving stages
of a company’s life cycle. The sequel is much better, because it highlights
what was covered in the first book, but then goes on to explain how management
should address the following, longer-term, life cycle issues every quarter to
avoid longer term valuation, exit and perpetuation problems:
1.
Once
you have become a high performance company that grows rapidly to dominate a
slow-growing niche, how do you continue to grow fast enough and profitably
enough to keep the good, young people on board when the niche will no longer
support such growth?
2.
Once
you become famous for high performance and deliver premium economic benefits to
all stakeholder groups – customers, employees, suppliers and shareholders – how
do you keep from backsliding due to arrogance and comfort? How do you stay
hungry enough to keep working hard at the risky, messy business of continual
innovation to fill new, tangential needs and opportunities that can be launched
from your core, platform business without killing the core operation?
3.
What
if a lot of the rank and file employees are good at what they do, get
continuously better in their job niche, but don’t want to be bothered with the
responsibilities of finance, saving to invest and re-skilling to support
adaptation to change as well as innovation?
4.
As
an older generation of shareholders starts to cash out, how do you plan for and
finance both the buyouts and recycling of the stock while also funding
continuous innovation and growth?
5.
If
you ultimately did decide to sell the core company or some of its spin-out
divisions to outsiders, how do you make it as valuable as possible to either an
outside buyer or a group of insiders who might want to do a next generation
leveraged buy-out from the parent?
The book is an easy, compelling read, because Jack’s
pragmatic, battle-scarred, but determined voice comes through in the telling of
a great story. This isn’t a dry, super-researched, theoretically detached,
B-school professor tome. For more encouragement to buy it, I recommend that you
read the reviews at Amazon.com and ask yourself what you are planning to do in
2003 to move significantly toward solving the five problems above.
If you aren’t making new, out-of-the-box changes to move
your company towards becoming a thriving business to have to then worry about
solving the 5 questions above, we can recommend (besides Jack’s book) our free
E-Booklet and our almost free (from resellers) video entitled “High Performance
Distribution Ideas for All”. For more on the video, see both the E-booklet and our
web site.
2. COMPANY
VALUATION QUESTIONS
A CEO of a wholesale distributor in
a building supply channel recently asked me in a tele-consulting session two
related questions: “What’s my company worth? And, when should I sell?” The
topping out of the housing bubble that has been stoking his sales for the past
4 years had gotten him thinking about these ultimate issues. (For more on the
housing bubble see the Nov. 19th Commentary #2, topic 2.)
The correct answer to this question
and most other big business questions is unfortunately not a simple one,
instead, “it depends” on a lot of inter-related factors such as:
1.
Different
types of buyers – financial, regional industry consolidators, next generation
insiders and liquid fools – who will all use different valuation methods. A
distribution business should rationally be worth the most on a present value
cash basis to the distributor in the same channel that is in the same or next
contiguous geography. The liquid fool from outside the industry who buys at the
top of the market may, however, pay the most for the wrong reasons.
2.
Acceptable
valuation methods to the buyer. Because distribution is a process/service
business that is often very dependent on the quality of and hands on presence
of whomever is managing it, they generally don’t sell for high multiples of
earnings before interest, taxes and depreciation (“EBITDA”) in public or
private markets. They will sell instead for within + or – 20% of “book value”
or their current assets less debt. But, potential sellers may get more over
time if they are willing to shoulder more future risk for more reward. “You
name the price and I will name the terms” is a negotiating line that suggests
that higher nominal prices are possible with terms involving: future payments,
earn-outs, seller asset guarantees and seller financing at low interest rates.
3.
Selling
at the top of economic valuation cycles for companies is vital. Distributors
that sold out to public roll-up companies for cash from ’97 to 99 got peak
valuation multiples. Now that we are in the third year of what I think will be
as long as a 10-year “secular bear market”, valuations for all companies have
dropped and on average will continue to drop over the next 5+ years.
(A dramatic example reported in
today’s (12-12-02) New York Times involves Burger King. A London-based
conglomerate has been trying to sell it for two years. They had a deal with
some financial, buyout funds for $2.5 billion announced in early July based on
hitting EBITDA numbers through the June closing. The EITDA came in 12% lower;
the deal was canceled and now re-done at a 33% lower price of $1.5 billion. The
seller is also providing financing for the deal this time around which suggests
that they are assuming more risk through the terms to nominally get a higher
deal price than an all cash down deal would yield. The industry/economy story,
of course, is not good. Too much capacity and too little demand for fast-food
burgers has created an on-going price war with McDonalds, et. al. Here is the
URL for the article: http://www.nytimes.com/2002/12/12/business/12BURG.html)
(Back to..) Our case study friend
could in theory still cut an OK cash valuation deal right now if the housing
bubble, which is just topping, lifted this year’s profits over last. The buyer
would also have to assume that:
a)
Housing
is a long-term investment vehicle instead of consumer consumption.
b)
Housing
volume and prices can, therefore, continue to grow faster than the incomes that
must buy them and
c)
The
US economy can grow again like it did for most of the nineties when
accelerating debt loads at consumer, corporate and government levels were
buying consumption and not productive asset investments. But, with total US
debt now exceeding $34 trillion or 3x the underlying economy that must service
the debt (Nov. 19th Commentary #2-topic 1) and with China’s
accelerating manufacturing base continuously causing US factory lay-offs (11-08
Commentary #1, topic 2), growth prospects look weak.
4.
For
the biggest increase in both the salability and cash value of a distribution
business, a company should set out to achieve “high performance distribution”
attributes and economics. If all the employees know:
a)
What
the number one niche of customers being pursued is.
b)
Who
the five+ most profitable customers within that niche are by heart at each
branch.
c)
Who
the five+ most important target accounts are within that niche.
d)
What
the exact service metrics are for defining “perfect service” for that niche and
can see them measured daily.
e)
Why
and how they are empowered to say “Yes” to any extra service request those key
accounts have as well as do any and all jobs necessary to make service metrics
happen everyday.
f)
And,
what is economically in it for them both short term and long term.
Then, any distributor will be on their way towards:
a)
Growing
at a rate that is 2 to 5 times greater than the average industry growth rate.
b)
Making
4 to 6 times the return on investment of the average player in the channel.
c)
Funding
future growth opportunities that convert “a job” into “a career”.
d)
And,
be able to fund any type of buyout from one generation of shareholders to the
next.
The bottom 95%+ of all distributors unfortunately have not
figured out the answers to the questions above, let alone figured out how to
teach them to all employees in a fast, affordable, effective way. If a journey
starts out with a first step, then might we ask ourselves: “What are we going
to do significantly different in 2003 that will move us beyond survival mode,
through the thriving mode to ultimately get to sustainable franchise value
mode?” Then, all the stakeholders will have a commonwealth system that will
both have a high valuation with a good chance for continuing to be a strong
commonwealth system even if the buyer is managerially incompetent. We think the
only affordable, distribution-specific, money-back-guaranteed, educational
solution to this question is our video, “High Performance Distribution Ideas
for All”.
3. Post-Bubble
Economics picture story: Why exit options and valuations are dropping.
For the first time since 1929, both the stock markets and
the economy have not revived in a typical recovery pattern after the Federal
Reserve has (this time) massively expanded money supply and reduced interest
rates. Why are super and faster-delivered, mega-doses of the traditional,
financial stimulation medicine not working? The prescription’s failure has made
forecasting fools out of every economist, Wall Street cheerleading analyst and
strategist with the notable exception of Stephen Roach at Morgan Stanley.
What’s different about our economy this time? Or, perhaps more importantly,
what is similar to the bubble economies of both 1929 and Japan in 1990?
Most economists have not been looking at either the
liability side of the balance sheets for individuals, corporations and
governments here in the US or the China free-market zone effects. For some
great economic charts that illustrate the massive increases in money supply,
mortgage debt, total debt and the erosion of factory jobs in the US go to this
URL:
http://www.prudentbear.com/creditbubblebulletin.asp (dated 12-6-02)
The author of this document, Doug
Noland, does a credit report update every week. His reports may be generally
beyond the ken of most of our readers, but try reading the first and last
paragraphs of his latest reports and skim a few topic sentences in between. The
bottom line is that when a society faces debt exhaustion from buying
non-productive assets, there is no additional stimulation that the government
can provide. Pumping the money supply to debase the currency and lowering
interest rates so people can borrow so they can consume more and inflate the
last asset bubble to pop (housing) while maintaining the same monthly payments
just adds to the debt pile and the day of reckoning. Instead of chugging
another pint, we need to sober up and slog through the debt of this post-bubble
economy.
CONCLUSIONS:
Has this commentary been provocative
enough to start you re-thinking 2003’s plans? Are you starting to wonder if
making incremental cost cuts within the old way of doing business isn’t the
answer? Is it time to switch to “high performance distribution principles”
which involve educating and signing up all employees to be part of the solution
in making customer profitability applications and zero error service economics
deliver? If you aren’t sure yet, we encourage you to read through our
E-Booklet, “New Tactics for a Different Type of Downturn” which is free via
email request. Then, you might take the next, money backed guaranteed step of
investing in our video. The downside risk is that you will lose a few hours of
your time getting a lot of your unspoken assumptions for how to run your
business challenged. Why not? If you have further questions or ideas, please
email us!
That’s all
for this week!
Bruce
Merrifield (bruce@merrifield.com or
919-933-7474)
